<PAGE>
 
                    (READING ENTERTAINMENT, INC Letterhead)



December 2,1998


Messrs. James J. Cotter and Michael Forman
c/o City Cinemas
950 Third Avenue 30th Floor
New York, New York 10022-1207

Re:  Possible Lease and Acquisition of Certain Beyond the Home Entertainment
Assets

Dear Sirs:

The Conflicts Committee (the "Committee") of the Board of Directors of Reading
Entertainment, Inc. ("REI"), acting for and on behalf of REI through the
delegated authority of the Board of Directors of REI, has met and considered
your proposal that certain entities controlled by you (referred to collectively
in this letter as "City Cinemas") a) lease to REI or to one or more of its
affiliates (referred to herein without differentiation or distinction as
"Reading") substantially all of its consolidated New York based cinema assets
(the "Cinema Assets"), b) sell to Reading its minority interest in the Angelika
Film Center (the "AFC Interest" and collectively with the Cinema Assets, the
"City Cinemas Circuit") and c) convey to Reading, in exchange for REI common
stock or, under certain circumstances, cash, all its New York based live theatre
business (the "Theatre Business").  The Committee believes that the leasing of
the Cinema Assets and the acquisition of the AFC Interest and the Theatre
Business, appropriately priced and structured, would be both consistent with
Reading's business plan to be actively engaged in the "Beyond The Home"
entertainment business, and in the best interests of Reading and its
stockholders.  Accordingly, the Committee has authorized me to communicate to
you the following proposed agreement in principle (the "Agreement in
Principle").

This proposal, if accepted by City Cinemas, is intended to be immediately
binding upon the parties as to the principal business terms set forth
hereinbelow and to obligate the parties to diligently and in good faith prepare
definitive documentation reflecting the intentions of. the parties as set forth
in this Agreement in Principle.  As certain of the assets involved are owned by
and/or subject to indebtedness owed to The Decurion Corporation or its
affiliates (collectively referred to herein as "Decurion"), Michael Forman
agrees to cause Decurion to approve such commercially reasonable modifications
to the documentation evidencing the leases, options to purchase and/or



encumbrances effecting such assets as may be reasonably requested from time to
time by Reading 
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in order to carry out the intentions of the parties under this Agreement in
Principle. The obligations of the parties will be subject only to a) receipt by
the Committee of a fairness opinion from a financial advisor selected by the
Committee to the effect that the terms of the transaction are fair to REI and
its stockholders from a financial point of view, b) Hart Scott Rodino clearance,
to the extent required, c) approval of the definitive documentation by REI and
City Cinemas, d) the approval, to the extent required, of City Cinemas' third
party lenders and landlords and e) such further closing conditions as are
customarily included in the definitive documentation for transactions of this
type. Except for the shareholder vote referenced immediately below by the
shareholders of REI with respect to the issuance of REI common stock in
connection with the acquisition of the Theatre Business, each party represents
to the other that all required corporate and/or partnership approvals have been
or will prior to the closing be obtained as may be necessary to carry out the
intentions of the parties under this Agreement in Principle. The parties agree
to use commercially reasonable efforts to have made any required Hart Scott
Rodino filings, to have completed the necessary definitive documentation and to
have obtained any third party consents by not later than January 29, 1999.

The issuance of stock by REI in consideration of the conveyance of the Theatre
Business (but not the transactions with respect to the City Cinemas Circuit or
the acquisition of the Theatre Business for cash) is subject to approval by the
stockholders of REI, as required by applicable Nasdaq National Market rules.
The parties agree to use commercially reasonable efforts to obtain such
approvals within one hundred twenty days of the execution, delivery and approval
of the definitive documentation memorializing the transactions summarized
herein.  In addition, some reasonable due diligence period may be required with
respect to the lease of the Cinema Assets and the acquisition of the Theatre
Business, to the extent that REI is not reasonably able to complete its due
diligence prior to the completion of the definitive documentation; such due
diligence period not to exceed thirty (30) days following the delivery of all
documents reasonably requested by Reading within ten (10) business days of the
execution and delivery of this Agreement in Principle.  The closing of the lease
of the Cinema Assets and the acquisition of the AFC Interest will take place as
soon as practicable following the execution and delivery of definitive
documentation, and, consequently, prior to any vote on the acquisition of the
Theatre Business.  However, it is the intention of parties that the closing of
the acquisition of the Theatre Business not be subject to any contingencies,
other than usual and customary closing conditions, once the closing of the lease
of the Cinema Assets and the acquisition of the AFC Interest has occurred.
Accordingly, the approval of the issuance of the REI common
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stock in connection with the acquisition of the Theatre Business is not a
condition to the lease of the Cinema Assets, the acquisition of the AFC
Interest, or the acquisition of the Theatre Business for cash.

City Cinemas counsel will take the lead in preparing the definitive
documentation.  While the definitive documentation is being finalized, all
discussions between the parties with respect to the transactions contemplated by
this Agreement in Principle will be maintained in strict confidence, and
information distributed only on a need to know basis, or as otherwise may be
required by applicable law.  It is understood that Reading intends to make a
press release with respect to the lease of the Cinema Assets and the acquisition
of the AFC Interest and the Theatre Business promptly following the execution
and delivery to it of this Agreement in Principle by City Cinemas.  Subject to
compliance with applicable Federal Securities and State Blue Sky laws and
applicable Nasdaq National Market and Philadelphia Stock Exchange rules and
regulations, no press release or other disclosure will be issued unless the
other party has first been provided with a reasonable opportunity to review and
comment upon such release.



REI will be permitted immediate access to the cinemas and theatres in order to
conduct such structural, mechanical, ADA and environmental review as REI may
reasonably deem to be appropriate under the circumstances, and City Cinemas will
reasonably cooperate with REI in its due diligence endeavors.  Each party would
bear its own costs with respect to this due diligence and documentation process,
and REI will indemnify and hold City Cinemas harmless in connection with REI's
due diligence activities at or about the cinemas and/or the theatres.



Within three (3) business days of the execution and delivery of this Agreement
in Principle by City Cinemas to Reading, together with written wire transfer
instructions, Reading will deposit with City Cinemas, by wire transfer, the
amount of $1 million as a good faith deposit (the "Deposit").  In consideration
of the Deposit, City Cinemas agrees that it will a) not discuss with any other
potential buyer (or any agent or representative of any such other potential
buyer) any possible lease or acquisition of all or any portion of the Cinema
Assets, the AFC Interest and/or the Theatre Business (other than dispositions of
personal property assets in the ordinary course of business ("Permissible
Dispositions")), b) not seek, encourage, respond to, accept, entertain or
consider any other offers or proposals for or inquiries with respect to any
lease or acquisition of all or any portion of the Cinema Assets, the AFC
Interest and/or the Theatre Business (other than Permissible Dispositions), c)
not enter into any agreement with respect to encumbering the Cinema Assets, the
AFC Interest and/or the Theatre Business or obligating Off Broadway, Inc., other
than Agreements in the ordinary course
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of business which will expire or which can be terminated without penalty or
charge at or promptly following the closing, and d) give prompt written notice
to Reading of any inquiry, offer or proposal by any third party with respect to
any possible lease or acquisition of all or any portion of the Cinema Assets,
the AFC Interest and/or the Theatre Business, including, without limitation, the
terms of such inquiry or proposal.

Upon the closing, the Deposit together with interest thereon accruing after
January 29, 1999 at the rate of 4% (to the extent the delay of such closing
beyond January 29, 1999 is not due to delays attributed to Reading) and accruing
through January 29, 1999 (as such date may be extended to the extent of delays
attributed to Reading) at the rate of 0% will be applied against the Option Fee
described hereinbelow.  In the event that the lease of the Cinema Assets fails
to close for any reason other than breach by Reading, the Deposit will be
promptly returned to Reading together with interest as specified above.  In the
event that the lease of the Cinema Assets fails to close due to breach by City
Cinemas, the Deposit plus interest as specified above will be promptly returned
to Reading.  In the event that the lease of the Cinema Assets fails to close due
to breach by Reading, City Cinemas may look to the Deposit as a fund to which it
may have recourse to collect any damages that it may have as a result of such
breach.  Neither the Deposit, the return of the Deposit, nor the retention or
payment of interest is intended to constitute liquidated damages, or as any
election of remedies or cap on damages in the event of breach by any party of
its obligations under this Agreement in Principle.



LEASE OF THE CINEMA ASSETS AND PURCHASE OF THE AFC INTEREST:

The parties are prepared to lease the Cinema Assets and to convey the AFC
Interest on the following terms:



1.   City Cinemas Circuit:  The City Cinemas Circuit is comprised of the
                            following assets:



                         a)   The AFC Interest,
                         b)   Cinemas I, II & III,
                         c)   Murray Hill and Sutton
                         d)   Village East; and
                         e)   Management Contracts(1)

------------------------------------------

     (1) During the term of the lease, Reading would assume City Cinemas'
obligations under its existing management agreements (the "Management
Contracts") and, subject to the terms and conditions of such contracts, would be
entitled to retain the management fee income associated with these contracts in
consideratior-t-of such services. The Management Contracts consist of the
management of the following
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                         City Cinemas represents that it has or will have a
                         transferable fixed price option to acquire the fee
                         interests underlying the Murray Hill and the Sutton
                         cinemas at any time prior to the expiration of the
                         initial term of the Operating Lease described below,
                         for an exercise price of $4 million (the "Murray/Sutton
                         Option") and, accordingly, has the ability to, in
                         effect, transfer the fee underlying such theatres. This
                         right to acquire the fee interests underlying the
                         Murray Hill and Sutton cinemas is also included within
                         the assets comprising the City Cinemas Circuit. The
                         term "Cinema Assets," accordingly, includes assets b)
                         through e) above, as well as the Murray/Sutton Option,
                         provided, however, that the Murray/Sutton Option may
                         only be exercised by Reading if the option to acquire
                         the Cinema Assets has first been exercised and the
                         funds for the exercise of the Murray/Sutton Option
                         provided by Reading.

2.   General Structure:  The transaction would be structured as a) the sale of
                         the AFC Interest in consideration of the issuance of an
                         interest only installment sale pron-dssory note and b)
                         an operating triple net master lease containing all
                         terms, conditions and indemnities usual and customary
                         for triple net leases (the "Operating Lease") of the
                         Cinema Assets (consisting of a sublease of the
                         respective leasehold interests underlying the cinemas
                         and a lease of the improvements, equipment and other
                         cinema assets owned by

------------------------------------------------------------

cinemas: the Gotham, the East Side Playhouse, the Angelika Film Centers in New
York and Houston, the St. Anthony Main, and the 86th Street Quad. In the case of
the 86th Street Quad, the Management Contract is for a period of ten (10) years,
ended January 30, 2008, and provides for the payment of a management fee equal
to 6% of the gross receipts of such cinema and includes a right of first refusal
to acquire the physical assets and the leasehold estate comprising such cinemas.
If Reading exercises its option to and does acquire the Cinema Assets, then the
                         ------
obligations and rights of City Cinemas under the Management Contracts would be
permanently transferred to Reading.
<PAGE>
 
                         City Cinemas (the "Cinema Improvements"), and an
                         assignment of the Management Contracts). For the term
                         of the Operating Lease, Reading would assume all of the
                         future liabilities of City Cinemas under and City
                         Cinemas would assign to Reading the future benefits of
                         the Management Contracts and the underlying leases. In
                         the event that Reading exercises its option to and does
                         acquire the Cinema Assets, the obligations and rights
                         under the Management Contracts would permanently
                         transfer from City Cinemas to Reading.



                         In order to provide business continuity and to provide
                         Reading with a reasonable period of time in which to
                         develop internal support facilities, City Cinemas would
                         agree to continue for a lin-Lited period of time, not
                         to exceed twenty-four months after closing, to provide
                         certain accounting and bookkeeping services with
                         respect to the operation of the Cinema Assets and the
                         performance by Reading of its obligations under the
                         Management Contracts. These services may be provided in
                         the context of a broader range of additional management
                         consulting services. However, the scope and extent of
                         these additional services, if any, is still under
                         discussion and no commitments have yet been made with
                         respect to any such management services.



                         City Cinemas has agreed to obtain, without cost to
                         Reading, either a) extensions through the end of the
                         Operating Lease (including the renewal term) of the
                         Murray Hill and Sutton leases, or b) to exercise the
                         Murray/Sutton Option so as to provide to Reading the
                         benefits
<PAGE>
 
                         of its bargain. It is understood. that, during the
                         initial term of the Operating Lease, the rent with
                         respect to the Murray Hill and Sutton cinemas will be
                         $310,000 per annum.

3. Purchase of AFC 
   Interest:             The purchase price of the AFC Interest would be paid
                         through the issuance of an interest only installment
                         sale promissory note in the amount of $4.5 million (the
                         "AFC Note"), which note would be due and payable ten
                         (10) years following the closing. Interest would be
                         paid quarterly at the rate of 7.75% (the "Contract
                         Rate"). The note will be nontransferable in form, and
                         permit offset by Reading.



4. Operating Lease:      Reading would lease the Cinema Assets for a period of
                         ten years, at a rent of $3,022,500 per annum, plus
                         passthroughs (including any underlying rent on any
                         overlease and all other occupancy costs). The Operating
                         Lease would include usual and customary triple net
                         lease provisions. At the end of the first term, Reading
                         would have the option to either a) renew the Operating
                         Lease for an additional period of ten years; b)
                         purchase the Cinema Assets (including the option to
                         acquire for $4 million the fee interests underlying the
                         Murray Hill and Sutton cinemas and to acquire all
                         remaining rights in the Management Contracts) at an
                         exercise price of $44 million (or $48 million if City
                         Cinemas has previously acquired the fee interests in
                         the Murray Hill and Sutton cinemas);(2) or c) terminate
                         the

-----------------------------------------

     (2) Reading will pay an option fee of $5 million in consideration of this
option to purchase the Cinema Assets (the "Option Fee"). The Option Fee will
initially be paid through a credit of the Deposit, plus accrued interest as
provided above, and the balance in the form of an interest only promissory note,
principal due and payable twelve (12) months from the closing. Interest will be
payable quarterly in arrears at the Contract Rate. The note may be prepaid by
Reading at any time.
<PAGE>
 
                         Operating Lease and return the Cinema Assets to City
                         Cinemas in accordance with the termination and
                         surrender provisions of the Operating Lease.

                         If the option to renew is elected, the rent would be
                         adjusted to the greater of the rent at the end of the
                         initial term and market calculated on the highest and
                         best use of the underlying real estate with respect to
                         the Murray Hill and Sutton cinemas and on the highest
                         and best use of the applicable leasehold estates (as
                         permitted under the applicable overlease) with respect
                         to the remaining Cinema Assets. If the parties cannot
                         agree as to such adjusted rent, the matter will be
                         determined pursuant to a baseball arbitration
                         procedure. Thereafter, rent would be adjusted annually
                         by CPI capped at a rate equal to the average increase
                         in CPI during the last three years of the initial term
                         of the Operating Lease.

                         If the option to purchase is exercised, then the
                         difference between $44 million (or $48 million in the
                         case the fee interests underlying the Murray and Sutton
                         cinemas have been previously acquired by City Cinemas)
                         and the $5 million Option Fee will be paid to City
                         Cinemas, and City Cinemas will transfer to Reading the
                         Cinema Assets free and clear of all liens arising as a
                         result of City Cinemas' actions.



                         If the option to terminate is elected, Reading will be
                         obligated to return the Cinema Assets to City Cinemas
                         in no less a state of condition and repair than such
                         assets were in at the time of the closing, reasonable
                         and customary wear and tear excepted, and free and
                         clear of all
<PAGE>
 
                         liens other than those resulting from the result of
                         City Cinemas' actions. All tenant improvements
                         installed in the cinemas during the term of the
                                                                  --
                         Operating Lease (including, without limitation, any
                         enhancements in the projection, sound and/or seating
                         systems) will be surrendered with and become the
                         property of City Cinemas upon any such termination.



                         The Operating Lease will include provisions obligating
                         City Cinemas to reasonably cooperate with Reading, at
                         Reading's expense and subject to the terms and
                         conditions of the underlying leases, in the event that
                         Reading should determine to develop any of the
                         properties for additional or for non-cinema uses or to
                         transfer its interest in any one or more of the Cinema
                         Assets. City Cinemas will not participate in any such
                         development or transfer, other than to the extent of
                         its right to receive fixed rent under the Operating
                         Lease; provided, however that City Cinemas will have a
                         reasonable right of approval with respect to any
                         assignment of all or any material portion of the leased
                         assets.


5. Subordination, 
   Attornment and Quiet 
   Enjoyment Agreements  The definitive documentation will include commercially
                         reasonable estoppel, subordination, attornment and non-
                         disturbance agreements which will, as conditions to
                         closing, be entered into between Reading and City
                         Cinemas' lenders and landlords.

6. Certain Credit 
   Facilities:           The Committee understands that the Cinema Circuit is
                         currently subject to certain secured loans, and that
                         the refinancing of such loans
<PAGE>
 
                         will depend in large part upon the credit of Reading
                         and the ability of Reading to meet its obligations
                         under the Operating Lease and the AFC Note --matters
                         not under the reasonable control of City Cinemas.
                         Accordingly, City Cinemas will have the option, at its
                         sole discretion, to either a) refinance the loans, in
                         whole or part, in which case REI will reasonably
                         cooperate, at City Cinema's expense, to the extent
                         reasonably required and consistent with its rights and
                         obligations under this Agreement in Principle, to
                         effectuate such refinancing or b) in the event and to
                         the extent that the loans are not refinanced with a
                         third party, to have Reading provide financing
                         consisting of (i) first a $4.5 million loan bearing
                         interest at the Contract Rate, with interest payable
                         monthly and the entire principal due and payable on the
                         tenth anniversary of the Closing (the "AFC Credit
                         Facility") and (ii) a standby credit facility (the
                         'Reading Credit Facility") of up to $28 million (which
                         credit facility would be on a junior mortgage basis,
                         with respect to such portion of such loans as are not
                         so refinanced, including, without limitation to
                         Nationwide's existing mortgage (such Nationwide
                         mortgage not to exceed $11.3 million)), provided that
                         in no event will such aggregate indebtedness exceed the
                         difference between the amount drawn on the Reading
                         Credit Facility and $39 million. Any refinancing must
                         be on terms which are consistent with Reading's rights
                         under the Operating Lease and the purchase options
                         described herein. The parties will enter into
                         commercially reasonable estoppel, subordination,
                         attornmnt and non-disturbance agreements reflecting
                         their respective rights and priorities.
<PAGE>
 
                         It is understood that, prior to the closing, all of the
                         assets comprising the Cinema Circuit (including,
                         without limitation, the leases underlying the various
                         cinemas, the Management Contracts, the Murray/Sutton
                         Option, and the AFC Interest) will be transferred to a
                         bankruptcy remote entity (Newco) and that the AFC
                         Credit Facility and the Reading Credit Facility will be
                         provided to Newco. Advances by Reading under the
                         Reading Credit Facility will bear interest (payable
                         quarterly) at the Contract Rate, with all principal due
                         and payable upon the earlier of (i) 180 days following
                         the tenth anniversary of the closing and (ii) the
                         closing, if any, of the acquisition by Reading of the
                         Cinema Assets. The Reading Credit Facility will be
                         subject to usual and customary lender remedies
                         (including, without limitation right of set-off, and
                         will be secured by a) the grant of commercial
                         reasonable security interests, b) a negative pledge
                         with respect to all of the remaining assets of Newco,
                         and c) a pledge of all of the stock of Newco. The
                         definitive documentation will permit the payment of
                         dividends and/or the making of other distributions by
                         Newco of its income, so long as a) such dividends or
                         distributions do not render Newco insolvent (provided
                         that for purposes of this test the non-cash assets of
                         Newco will be valued at $52.5 million), b) Newco is not
                         otherwise in breach of its obligation under the
                         definitive documentation and c) the making of such
                         dividend or distribution will not cause Newco to be
                         otherwise in breach of its obligations under the
                         definitive documentation.
<PAGE>
 
                         The parties recognize that the filing of a traditional
                         mortgage in New York could involve filing fees and
                         assessments of an amount in the range of $1 million,
                         and agree to work together in good faith to achieve
                         commercially reasonable security for any financing
                         provided by Reading without, to the maximum extent
                         possible, imposing upon either party liability for such
                         mortgage filing fees and assessments while still
                         achieving commercially reasonable protections for
                         Reading. Messrs. Cotter and Forman agree that they will
                         be personally liable for any loss suffered by Reading
                         as the result of the incurrence by Newco of any debt
                         encumbering the assets of Newco in violation of any
                         negative covenant running to the benefit of Reading.



                         It is the intention of the parties that Reading be
                         afforded commercially reasonable protection so as to
                         achieve for Reading the same level of economic
                         protection with respect to its interest in the real
                         property assets of Newco that it would have had if
                         Newco's.obligations to it had been secured by a duly
                         executed and recorded mortgage, but no greater economic
                         protection with respect to such real property assets.



                         Drawdown on the AFC Credit Facility may be made at any
                         time during that period beginning eighteen (18) months
                         after the closing and ending twenty-four (24) months
                         after such closing. Drawdowns on the Reading Credit
                         Facility may be made at any time after eighteen (18)
                         months following the closing (the "Initial Draw Down
                         Date"). With respect to any draw down during the ninety
                         (90) day period
<PAGE>
 
                         following the Initial Draw Down Date, one hundred
                         twenty (120) days' draw down notice must be given. With
                         respect to any draw down thereafter, at least one
                         hundred eighty (180) days' notice must be given. No
                         drawdowns may be made with respect to the Reading
                         Credit Facility with respect to any notice given after
                         the third (3rd) anniversary of the closing.

7. Assumption of 
   Liabilities:          At the closing, Reading will assume for the term of the
                         Operating Lease all future obligations of City Cinemas
                         under the lease pertaining to its executive office
                         space, and all underlying leases, existing film
                         licensing arrangements, and under the Management
                         Contracts, and will fully indemnify City Cinemas with
                         respect to any such obligations arising during the term
                         of the Operating Lease. Reading will be entitled to all
                         management fee income generated by the Management
                         Contracts and will be assigned the benefits of these
                         Management Contracts during the term of the Operating
                         Lease (and for the duration of the Mana ement
                         Contracts, in the case of exercise by Reading of its
                         option to acquire the Cinema Assets). The Operating
                         Lease will provide for usual and customary prorations.

                         City Cinemas will agree to provide to Reading, either
                         directly or indirectly through an affiliate reasonably
                         acceptable to Reading, upon Reading's request,
                         bookkeeping, accounting and related services without
                         charge for a period of up to twenty-four months
                         following the closing, so long as Reading agrees to
                         conform to the policies and procedures reasonably
                         required by City Cinema's affiliate for standard
                         bookkeeping services. Except for
<PAGE>
 
                         those liabilities which are specifically assumed by
                         Reading, City Cinemas will be responsible for all of
                         its past and future liabilities, including, without
                         limitation, any obligations it may have to employees
                         and any unknown or undisclosed liabilities.

8. Closing               The closing will be as soon as practicable after the
                         execution of definitive documentation and the
                         satisfaction of all conditions to closing. It will be a
                         condition to closing that City Cinemas obtain all
                         consents and approvals, if any, required from any
                         unaffiliated commercial lender having a security
                         interest in the Cinemas Assets and of all unaffiliated
                         lessors under applicable overleases, to the extent
                         required by such leases, and that the leases underlying
                         the Murray Hill and Sutton be reasonably extended, as
                         previously discussed hereinabove.

9. Miscellaneous:        The definitive documentation will have such other
                         terms, conditions, covenants, representations,
                         warranties and indemnities as would customarily be
                         included with respect to a transaction of this type.
                         City Cinemas will provide to REI, without charge, such
                         audited and unaudited historical financial statements
                         as may be reasonably required to be included within
                         REI's reports filed with the SEC.

                         All lease initiation taxes (estimated at in the range
                         of $160,000 to $180,000) will be the responsibility of
                         Reading. All other sales and transfer taxes will be the
                         responsibility of City Cinemas.



                         The parties will cooperate to provide Reading with
                         commercially reasonable assurances as to
<PAGE>
 
                         title, including, without limitation, commercially
                         reasonable title insurance (to the extent reasonably
                         available). The costs of any such policy of title
                         insurance will be shared on a 50/50 basis as between
                         City Cinemas and Reading; provided that 100% of such
                         costs will be initially advanced by Reading and that
                         50% of such costs (plus an interest factor compounded
                         annually and calculated at the Contract Rate) will be
                         treated as a credit against the exercise price of
                         Reading's option to acquire the Cinema Assets, in the
                         event Reading elects to exercise such option.


ACQUISITION OF THE THEATRE BUSINESS:

The parties are also prepared to acquire and sell the Theatre Business currently
owned by a corporation wholly owned by Messrs.  Cotter and Forman on the terms
set forth below.  The assets of this company, Off Broadway Investments, Inc.
("OBI"), consist of three live theatres (the Minetta Lane, the Orpheum and the
Union Square (the "Theatres")).  It is understood that City Cinemas would prefer
to convey its interest in the Theatre Business in the context of a stock
transaction.

1.   Structure:          Subject to the limitations set forth below, the
                         transaction will be structured as the merger of a
                         subsidiary of REI and OBI, in consideration of the
                         issuance of REI Common Stock. This subsidiary could,
                         but need not be, the same entity as would be leasing
                         the Cinema Assets.

2.   Purchase Price:     The purchase price will be that amount equal to eight
                         times (SX) 1997 EBITDA for the Theatre Business, less
                         $100,000 to compensate Reading for the lack of any
                         recorded easement from the rear of the Orpheum Theatre
                         to Saint Mark's Place, (the "Theatre Business Purchase
                         Price") and will be paid, subject to the immediate
                         following paragraph, through the issuance of REI Common
                         Stock, valued at $9.00 per share, in an amount equal to
                         the Theatre Business Purchase Price.
<PAGE>
 
                         The transaction is subject to the issuance to the
                         Committee of a fairness opinion. In the event that a)
                         the financial advisor to the Committee informs the
                         Committee that it is prepared to deliver a fairness
                         opinion to the effect that the Theatre Business
                         Purchase Price is fair to REI from a financial point of
                         view, but would be unable to deliver an opinion that
                         the issuance of REI Common Stock at $ 9.00 per share is
                         fair to REI from a financial point of view in the
                         context of the instant transaction, and b) on such
                         basis the Committee concludes that it would be
                         imprudent to issue REI Common Stock in exchange for the
                         Theatre Business, then c) the Theatre Business Purchase
                         Price will be paid in cash, rather than in REI Common
                         Stock, and no shareholder approval will be required.



                         The issuance of REI Common Stock also subject to the
                         favorable vote of the Reading shareholders. Reading
                         agrees to use commercially reasonably efforts to obtain
                         such approval by April 30,1999. However, in the event
                         that, for any reason, attributable to Reading, such
                         approval is not obtained by April 30, 1999 or in the
                         event that Craig Corporation should sooner advise
                         Reading that it will not vote in favor of the issuance
                         of REI Common Stock, then subject to the satisfaction
                         of all other applicable closing conditions, the
                         acquisition of the Theater Business by Reading will
                         promptly close and the Theater Business Purchase Price
                         will be paid in cash, rather than in REI Common Stock,
                         and no shareholder approval will be required.



3.   Assets Conveyed:    The assets conveyed will be all of the stock of OBI.
                         The assets of OBI include a) the fee interest in two
                         live theatre properties (the Minetta Lane and Orpheum),
                         b) a leasehold estate in the third live theatre (the
                         Union Square) and c) all of the assets generally
<PAGE>
 
                         required for the proper conduct of OBI's live theatre
                         business. However, the risk of undisclosed liabilities
                         will rest with the selling stockholders.

4.   Stock Terms:        The stock issued will be initially unregistered.
                         However, Reading will grant to City Cinemas one demand
                         registration and unlimited piggyback registration
                         rights, such registration to be at the cost and expense
                         of REI subject to usual and customary terms and
                         conditions.


5.   Closing:            Under applicable Nasdaq National Market rules, Reading
                         will be required to obtain shareholder approval for the
                         issuance of REI Common Stock in the transaction. Even
                         though Craig Corporation has sufficient voting power to
                         cause approval of such issuance by itself, Nasdaq
                         National Market rules require that such approval be
                         obtained at a meeting, in which proxies are solicited
                         by the issuer. Accordingly, it is recognized that it
                         would likely take approximately 90 to 120 days for the
                         proxy to be prepared, reviewed by the SEC and sent to
                         shareholders and to hold the required meeting of
                         shareholders.

6.   Miscellaneous:      It is the intention of the parties that, to the extent
                         REI Common Stock is issued in connection with the
                         merger, the transaction be treated as a tax free
                         reorganization, and that the definitive documentation
                         have such additional terms, conditions, covenants,
                         representations, warranties and indemnities as would
                         customarily be included in a transaction of this type.
                         City Cinemas will provide to REI, without charge, such
                         audited and unaudited historical financial statements
                         as may be reasonably required to be included within
                         REI's reports filed with the SEC. All sales and
                         transfer taxes will be the responsibility of City
                         Cinemas, but will be funded by Reading and treated as a
                         credit against the purchase price. The
<PAGE>
 
                         costs of any title policy will be shared 50/50 by
                         Reading and City Cinemas; provided, however, that the
                         50% which is the responsibility of City Cinemas will be
                         advanced by Reading and treated as a credit against the
                         purchase price at the closing.



If you are prepared to proceed upon the above referenced terms, please execute
and return a copy of this agreement in principle to the undersigned.  This
Agreement in Principle will expire if not executed and returned to Reading by
5:00 p.m. (New York local time) on Friday, December 4, 1998.



Sincerely,

/s/ Edward L. Kane

Edward L. Kane
Chairman, Conflicts Committee



ACCEPTED AND AGREED AS OF THIS 4th DAY OF   DECEMBER  1998.
                              -----       ------------     



By:  /s/ James J. Cotter
     -------------------
     James J. Cotter, for and on behalf
     of himself and City Cinemas


By:  /s/ Michael R. Forman
     ---------------------
     Michael Forman, for and on behalf
     of himself and City Cinemas

cc:  John Sullivan
     Gregory Brundage
     S. Craig Tompkins
     Robert Smerling
     Michael Margulis, Esq.